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Harry Dent on Why We Need to Kill Market Bubbles and What It Takes to Be a Contrarian

Demographics guru and economic prognosticator Harry S. Dent, Jr. believes the bull market has hit its top. More importantly, we may be staring the next depression right in the face at this very

Demographics guru and economic prognosticator Harry S. Dent, Jr. believes the bull market has hit its top. More importantly, we may be staring the next depression right in the face at this very moment. While his contrarian perspective is well known, those familiar with Dent's work with demographic trends and behaviorial economics know that his forecasts are based on long-term trends that have proven out over numerous market cycles throughout the U.S. economy's history. He is the author of The Demographic Cliff: How to Survive and Prosper During the Great Deflation of 2014-2019 and The Great Crash Ahead: Strategies for a World Turned Upside Down, and editor of Economy & Markets, which uses the power of demographic trends and purchasing power to accurately identify economic and market boom and busts.

EQ: The Dow is currently trading at an all-time high, and the brief pullback we endured in mid-October only served as a minor only bump along the way. With all that said, you’ve been expecting that we’re going to hit a top here, which should start a collapse down to under 4000 on the Dow over the next five or six years. Do you still see that turn happening within the next six months?

Dent: I do. I think it may even be happening now. For a while, I’ve been looking for an 8% to 10% correction, like we saw in 2007 before reaching the top. We recently hit new highs, which is about 1.5% above the last high of 17,350. We also aren’t seeing confirmation from the small-caps and the advanced decline line, which is a classic sign of a top or a near-top. That’s also what we saw in 2007 before the crash.

We saw a peak in July, followed by a 10% downturn into August. Then in September and early October we saw a rally to new highs, and the advanced decline line did not confirm.

Number one, we may be close to a peak, literally in the next week or so. Second, there’s two patterns we see broadly, one of which I’ve been talking about for a long time: the megaphone pattern of higher highs and lower lows.

EQ: We’ve discussed this pattern before in previous interviews. What are some historical examples of this?

Dent: This broad megaphone pattern peaks on a trend line, going higher, and then re-bottoms to lower lows. We saw this in the 2000 peak and 2002 bottom, and 2007 peak and early 2009 bottom. Now we’ll see the peak in 2014, and a bottom around 2016 to lower lows.

The last major long-term peak in the markets in the late ‘60s to early ‘70s had the same megaphone pattern. It’s just a little more compressed and a little less exaggerated. We had a peak in ’65, ’68 and late ’72, and then the biggest crash came in ’73 and ’74. That’s what I’m looking for.

We’ve been looking for this megaphone pattern to peak. You’ve got to remember, it’s rising over time slightly. So we hit that peak at 17,350 in September, and then we had this near-10% crash. Now we’re at a new high, and we’re right on that megaphone trend line again. So, this megaphone pattern would say that if we do peak here, we can’t bust much above 17,500, and that’s possible, because Japan just upped its QE, and people expect the ECB in Europe to do the same, even though we’re tapering.

EQ: But Europe’s stimulus is still pending.

Dent: Right, because Germany is saying, “Nein, don’t do this.” There’s a big fight in Europe. If Germany wins that fight in the next few months, that’s going to be bad for the markets. If Germany loses and allows the ECB to follow Japan and up the QE, then that’s going to be more positive, which could cause a break above 17,500. I think we could have a top here. There is also a smaller pattern in the market since June, and it’s the same megaphone pattern.

Since June, we keep making slightly higher highs on each rally, but each decline has gone lower. So, this pattern says we could peak slightly above the 17,500 area on the Dow, and then the next drop would take us to about 16,500 or so —a new low in the Dow.

To me, if that happened, it would confirm this is a top. We never know. We always say, “Bubbles are like dropping pebbles of sand on a mound.” You keep building the mound, it keeps getting steeper, and at some point, one pebble of sand will cause an avalanche. That’s the way bubbles are. Bubbles just go up, and up, and up, and they get all the momentum behind them. The higher they go, the more people feel confident and jump in, which, of course, is the wrong thing to do. But, at some point, something happens—the last investor gets in, or something goes wrong in the world—maybe Russia invades Ukraine, or the China bubble starts to burst, or Germany’s next report is, “Oops. Things aren’t just down 4%, they’re down 6%-8%.”

So, we see two patterns: one long-term, and one short-term, converging here. Now, we don’t know if this is going to play out, but we could break above this larger megaphone pattern. This smaller megaphone pattern could break above and/or not make a new low in the next month or two. I think that should happen very quickly, if it does, we’re watching very closely. We’re definitely telling investors, “Don’t look a gift horse in the mouth here.”

EQ: Can you elaborate on what you mean by that?

Dent: We’ve had a Fed-induced rally. It’s artificial, but it’s the second steepest rally we’ve had since 1995 to 2000. This is a bubble, and it’s going to burst at some point. We’re at new highs every time, and when we went to 17,200-17,300-17,350, we said, “Look, this is a good time to start selling stocks.” We won’t know if it’s a top until we break some really key areas, maybe 10% or 15% lower from here, but why wouldn’t you want to get out here?

This megaphone pattern says there’s not a lot of upside here unless we really break through it, and we haven’t for months. That’s why we’re saying this is a good time to sell. Even if it breaks up, maybe there’s another 10% on the upside if it breaks above this. I don’t think that’s going to happen, but the downside of this megaphone is about 65%.

Our next target is, we’re saying 3,000 or 4,000 on the Dow over the next maybe five or six years from now, in late 2019 or 2020. That’s when our most basic fundamental indicators are still pointing down before some of them start to turn up.

So, I think the ultimate low is more like five to five-and-a-half years from now. However, the next crash on this megaphone pattern should take us down to about 5,500 to 6,500, depending on how quickly it happens, and that’s going to be bigger than the last crash. Who would want to sit through that for another 1% or 2%–maybe 5% to 10% at most—before this bubble gets crazy? It’s already crazy.

EQ: While we might not find the bottom of the next crash until 2020, you do think we’ll endure the major portion of that downturn by 2016. Is that because the initial crash will happen is a lot quicker before we reach the actual bottom?

Dent: In the context of this series of bubbles and crashes, the next crash is likely to be the most extreme. It will be greater than the 2008-2009 crash, which was about 55% for the Dow and the S&P 500. This is going to be 65%, give or take a few percentage points, and more importantly, we’re never going to see new highs for decades after this—just like in 1929 or ’68. This is the biggest crash to avoid. When it happens, there will be about a 40% to 50% bounce from there, but we’re not going to go back up to 18,000. When central banks have put this much stimulus and it fails again.

Japan’s strategy is even more pronounced. The Japanese government keeps upping their stimulus to extreme levels. They’re like two-and-a-half to three times what we we’re doing at our peak, and they’re still barely growing. They can’t even get up to 2% inflation, and they’re not going to get there. The aging of their population and their massive debt all point to deflation.

Around the globe, everybody’s fighting the deflation crisis, but the truth is, it needs to happen. It’s going to be painful—like the early ‘30s—but it’s going to kill the education bubble, kill the healthcare bubble, kill the financial assets bubble, and make housing more affordable for the next generation.

EQ: So in a way, we need our economies to reset in order to grow again?

Dent: It will make businesses much more efficient, and banks will have to write down their loans, all of which will benefit consumers and businesses. In short, if we just let it happen, it’s going to set the stage for the next boom. Nobody wants it to happen, because nobody wants to have the next Great Depression on their watch. That’s understandable, but it’s stupid. I think we’re getting closer to something going wrong. Germany’s economy keeps collapsing. For a year now, we’ve said that Germany will have the worst demographics of any country over the next eight years. It’s worse than Japan in the 1990s.

Japan went down on those demographics—their bubbles burst, even though the rest of the world was booming. That’s how powerful demographics are–when they turn against you, what can you do?

What can you do when you’ve got older people that aren’t going to spend money, and not enough young people to spend money and buy houses?

Whether you’re fiscally responsible like Germany, or irresponsible like Japan, your economy is still going to slow, whether you like it or not. China is another example. Their economy is slowing, and their bubble keeps showing cracks in the walls. The country’s affluent citizens are starting to panic, and they own most of the real estate. So, when that bubble bursts, China’s wealth is going to evaporate even faster than Japan’s in the early ‘90s. At that point, they’re going to stop buying real estate in London, New York, San Francisco, L.A., Orange County, Vancouver, Sydney, Melbourne and Singapore, ending those large bubbles.

EQ: One of the catalysts that people are pointing to right now is that the strength of the dollar is attracting an inflow of money from foreign investors. Do you believe in that will provide the U.S. with some sort of buffer?

Dent: I often emphasize that many people are simply ignoring the weakness of Germany, and they’re holding up the European Union. They’re also not looking at China, one of the most extreme bubbles in history. Further still, intertwined with China’s bubble is commodities, and those keep collapsing. Gold keeps going down. Copper keeps going down. Commodity prices peaked in 2008 on a classic 29- to 30-year cycle that has repeated over the last 200 years in modern history.

People keep saying, “Oh, the emerging world’s going to keep growing its middle class, and they’re going to consume more commodities.” This is incorrect. When commodity prices go down, their best industries and stocks go down. So, we’ve been predicting for many years that the dollar’s only going to go up; not down.

In this reset, when the dollar went down 58% from 1985 to early 2008, we were saying that commodities are going to keep going down. That hits countries in the emerging world, not as much in India but it hits South America, it hits the Middle East and the oil exporters, it hits Africa. The parts of the world that still has positive demographics has this commodity trend going against them. So, a rising dollar is bad for commodities and a slowing global economy.

EQ: It’s creating a commodities crunch for these markets.

Dent: That’s partly why China keeps slowing. We just found a new leading indicator from a company called Fathom – a China momentum indicator that tracks well with the past. This indicator says that in the next year, China’s GDP growth is going to slow to 4% to 5%. This is significant.

In the last Great Recession, in 2008 and 2009, it went down to 6% growth. For China, 6% is a recession. For us, 6% growth would be nirvana, but for them, with all their overexpansion and leverage, that is a nightmare. So, what if they go to 4%-5% in the next year? If China slows down, then the demand for commodities slows down even more, because they’re the biggest consumer of commodities. Then both their consumers and their exporting manufacturing industries will slow.

That’s why we see the rise of the dollar as a mixed picture for the U.S. It will hurt our export competitiveness, but it will make our foreign earnings from our biggest S&P 500-type companies more valuable.

For the emerging world, though, it is not good that the dollar is going up, and they’re the only strong part of the world in terms of their demographics. We don’t see any way out of this—this is a bubble. It’s artificial. We should have had the Great Depression in 2008, 2009, 2010 and 2011.

EQ: If that would have happened, then that would’ve reset the megaphone pattern to less extreme levels?

Dent: Right, because by now, it would largely be over, and we could enjoy legitimate growth. But we didn’t have it because central banks said, “No, we’re not going to let it happen.”

I think they’re going to lose control here, because commodity prices keep falling, Germany keeps weakening, China’s bubble keeps bursting. Also, in the U.S., I think car sales are going to peak this year, because people spend the most money on cars at age 53.

For the peak of the baby boom, that’s 2014. Then in 2015 and 2016, we are going to see cars sales fall just like housing did, and that’s a problem. The wealthiest people, who peak later than Homer Simpson at age 46, peak between 51 and 53 and that’s going to tail off after this year.

So, we see the fundamental trends getting worse just as the Fed is tapering and thinking things are OK. Japan and Europe are desperately trying to stimulate, because they’re already dying.

They’re aging much faster than us, and their debt is even worse than ours. I think this bubble’s going to blow.

EQ: I wanted to get your thoughts on how people can prepare themselves for this. You recommend that investors sell into strength at any chance they can get from the stock market, and then move into T-bills. This is more as a way to preserve their capital than for yields. That’s certainly a contrarian play considering where both markets are heading now, and contrarian plays are usually not easy for investors. Do you have any advice or suggestions on how they should look at the market to get into the proper mindset to deal with going against the grain?

Dent: When I can get people in a room for an hour-and-a-half, two-thirds will be convinced to do this. I just tell people, “Don’t look a gift horse in the mouth.” We’ve had the greatest bubble in history, all the way back from the 1990s and even the ‘80s. Things are getting really stretched. Governments are getting more and more desperate, having to stimulate more and more to keep this crazy bubble going. It’s better to get out a little early than a little late, because when bubbles burst, they don’t correct—they crash.

The NASDAQ went down 40% in the first two months of the first crash. Almost half of its decline happened in the first two months. If you didn’t get out, you were dead already. If you preserve your capital, you’ve already made great gains because of this bubble.

Preserve your capital, then wait and see if the markets crash in the next year. If they don’t crash in the next year, then maybe you get back in and maybe you miss 5% or 10%. But, what if they do crash, and you lose 40%? Or in the next few years you lose 65%, which is our projection?

That’s just not worth it. The risks outweigh the returns here, by far. It’s almost 10-to-1. I’d say you might have 6% on the upside at best, and 65% on the downside if what we’re saying happens.

That’s not a good deal. So, be smart. I tell people, “Act like the smart money.” When things are highly valued and there are no good deals out there, sell more. When things crash, be like Warren Buffett and buy good companies, or buy good investments.

EQ: So you’re saying, the better bargains are on the way?

Dent: Yes! I think way better bargains.

If you don't feel that U.S. culture (and much of the world in different ways) is in turmoil, you are not paying attention.
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